After a protracted six-year recession, Croatia returned to growth in 2015 and is now entering its fifth year of recovery. Access to the European Union (EU) internal market helped connect the economy to global value chains, and tourism is experiencing historic highs. Nevertheless, these factors are not enough to deliver pre-crisis growth rates. GDP is currently hovering roughly 1% lower than in the pre-crisis period, and youth unemployment remains high.

Source: World Bank, Fitch Solutions

2. Major Economic/Political Events and Upcoming Elections

July 2013Croatia joined the EU as its 28th member.

January 2015Kolinda Grabar-Kiratovic was elected Croatia's first female president.

November 2015The general election failed to produce an outright winner. Following protracted talks, Tihomir Oreskovic became Prime Minister in January 2016.

July 2016Parliament was dissolved and fresh elections were called for in September.

September 2016Elections were held and the Croatian Democratic Union (HDZ) party won the largest number of seats.

October 2016A coalition government headed by HDZ leader Andrej Plenkovic, took office.

Croatia has been a member of the WTO since November 30, 2000. As of July 1, 2013, Croatia became a member state of the EU.

The EU is party to some 50 FTAs and, consequently, access to other markets of the countries concerned is currently mediated through those agreements. The EU’s scheme on generalised system of preferences (GSP) entered into effect on January 1, 2014. Under the scheme, tariff preferences have been removed for imports into the EU from countries where per-capita income has exceeded USD4,000 for four years in a row. Regarding Hong Kong, the territory has been fully excluded from the EU’s GSP scheme since May 1, 1998.

Prior to Croatia's accession to the EU, the country had signed over 40 international trade or economic cooperation treaties, with further agreements in place regarding investment promotion and protection. As part of EU membership negotiations, these agreements were adjusted to ensure their validity continued once Croatia joined the EU, or voided as the EU agreement took precedence. Once goods are cleared by customs authorities upon entry into any EU member state, these imported goods can move freely among EU member states without any additional customs procedures.

Import tariffs: Croatia applies the EU's Common External Tariff (CET), which means goods manufactured and imported from within the EU are not subject to customs charges. The average tariff rate for Croatia is just 1.3%, which is among the lowest globally, although goods imported from outside the EU will incur duties of between 0-48.5%.

Customs and non-tariff barriers: Trade bureaucracy and customs delays are a significant hindrance to foreign investors, particularly those outside of the EU. Though there are increasing efforts to reduce trade bureaucracy, paper-based procedures remain cumbersome and costs and connectivity issues add to market barriers.

Anti-dumping and countervailing duties: The EU has imposed various anti-dumping measures on a wide range of products - predominantly in the areas of textiles, parts, steel, iron and machinery on goods coming from China and a few other Asian nations to protect domestic industries. On November 13, 2016, the European Commission imposed a provisional antidumping duty on imports of some primary and semi-processed metals from China. The rate of duty is between 43.5%-81.1% of the net free-at-Union-frontier price before duty, depending on the company. In the same vein, the rate of duty for similar goods from Belarus is 12.5% of the net free-at-Union-frontier price before duty. In March 2016, the European Commission imposed a definitive countervailing duty (8.7% or 9%) on imports consisting largely of textiles products originating in India.

Trade defence measures: In 2016, the European Commission introduced an import licencing regime for steel products exceeding 2.5 tonnes. The regulation will be active until May 15, 2020. Agriculture: In Q215, the European Commission issued regulations on trade restrictions on cattle, beef, watermelons and prepared tomatoes with Turkey. This will help to protect domestic agriculture and regional farming businesses.

State aid and protected sectors: In March 2016, the European Commission announced a new support package for European farmers, which involves mobilising an estimated EUR500 million within the next two years. The intervention ceilings for dairy and other farm products have been nearly doubled. This will limit the ability of foreign businesses to export products, such as milk, fruits and vegetables to Croatia.

Nine types of goods imported into the EU are subject to licensing. These goods are (broadly): textiles; various agricultural products; iron and steel products; ozone- depleting substances; rough diamonds; waste shipment; harvested timber; endangered species; and drug precursors. No quotas are imposed on textiles and clothing exports, as well as non-textile products exports from Hong Kong and the Chinese mainland at present.

The Croatian economy is dominated by the services industry (which accounts for almost 70% of GDP), of which tourism is an important element. Tourism accounted for 71.0% of services exports in 2016. Croatia's most valuable traded products are machines, technical equipment, medicine, and crude and refined petroleum. The country is a major manufacturer of passenger and cargo ships, and is developing its automobile manufacturing capacity, as well as being a textile manufacturing hub. Croatian product exports stood at USD11.6 billion in 2016, up from USD11.1 billion in 2012. Much of the import sector is dedicated towards Croatia's manufacturing sector (for export products), with machinery, chemical products and base metals making up three of the top five imported products.

Source: WTO - Trade Policy Review, Fitch Solutions

6. Trade Agreement

6.1 Trade Updates

On September 21, 2017, the Canada Comprehensive Economic and Trade Agreement (CETA) agreement between the EU and Canada provisionally entered into force. It will enter into force fully and definitively when all EU Member States parliaments have ratified the Agreement.

6.2 Multinational Trade Agreements

Active

EU: Croatia is a member of the EU that comprises 28 member states, and it follows EU's common external trade policy and measures. All EU member states adopt common external trade policy and measures and most of the country’s trade is with other members.

European Economic Area-European Free Trade Association (Iceland, Liechtenstein, Norway and Switzerland): The European Economic Area (EEA) unites the EU Member States and the three EFTA States (Iceland, Liechtenstein, and Norway) into an Internal Market governed by the same basic rules. These rules aim to enable goods, services, capital, and persons to move freely about the EEA in an open and competitive environment, a concept referred to as the four freedoms. While this agreement enhances trade ﬂows between these countries, only Switzerland is a major trading partner to the EU.

EU-Turkey Customs Union: the EU and Turkey are linked by a Customs Union agreement, which came into force on December 31, 1995. Turkey has been a candidate country to join the EU since 1999, and is a member of the Euro-Mediterranean partnership. The customs union with the EU provides tarff-free access to the European market for Turkey, benefitting both exporters and importers. Turkey is the EU's fourth largest export market and fifth largest provider of imports. The EU is by far Turkey's number one import and export partner. Turkey's exports to the EU are mostly machinery and transport equipment, followed by manufactured goods. At present the Customs Union agreement covers all industrial goods, but does not address agriculture (except processed agricultural products), services or public procurement. Bilateral trade concessions apply to agricultural as well as coal and steel products. In December 2016, the European Commission proposed the modernisation of the Customs Union and to further extend the bilateral trade relations to areas such as services, public procurement and sustainable development.

EU-CETA: CETA is expected to strengthen trade ties between the two regions. Some 98% of trade between Canada and the EU is duty-free under CETA. The agreement is expected to boost trade between partners by more than 20%. CETA also opens up government procurement. Canadian companies will be able to bid on opportunities at all levels of the EU government procurement market and vice-versa. CETA means that Canadian provinces, territories and municipalities are opening their procurement to foreign entities for the first time, albeit with some limitations regarding energy utilities and public transport.

Ratification Pending

EU-Japan Trade Agreement: In July 2018, the EU and Japan signed a trade deal that promises to eliminate 99% of tariffs that cost businesses in the EU and Japan nearly EUR1 billion annually. According to the European Commission, the EU-Japan Economic Partnership Agreement (EPA) will create a trade zone covering 600 million people and nearly a third of global GDP. The result of four years of negotiation, the EPA was finalised in late 2017 and is expected to come into force by the end of the current mandate of the European Commission in 2019. The total trade volume of goods and services between the EU and Japan is EUR86 billion. The key parts of the agreement will cut duties on a wide range of agricultural products and it seeks to open up services markets, in particular financial services, e-commerce, telecommunications and transport. As of August 2018, the agreement is awaiting ratification by the European Parliament and the Japanese Diet, following which it could enter into force in 2019. At the same time, negotiations with Japan continue on investment protection standards and investment protection dispute resolution. Japan is the EU’s second biggest trading partner in Asia after China. EU exports to Japan are dominated by motor vehicles, machinery, pharmaceuticals, optical and medical instruments, and electrical machinery. The agreement awaits ratification from all parties concerned.

EU-SADC Economic Partnership Agreement (Botswana, Lesotho, Mozambique, Namibia, South Africa, Swaziland, Angola, Comoros, Democratic Republic of the Congo, Madagascar, Malawi, Mauritius, Seychelles, Tanzania, Zambia and Zimbabwe): An agreement between EU and SADC delegations was reached in 2016 and is awaiting ratification, with 13 of the 35 needed states having ratified the agreement as of April 2018.

EU-Central America Association Agreement (Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica, Panama, Belize, and Dominican Republic): An agreement between the parties was reached in 2012 and is awaiting ratification (29 of the 34 parties have ratified the agreement as of April 2018).

Under Negotiation

EU-Australia: The EU, Australia's second largest trade partner, has launched negotiations for a comprehensive trade agreement with Australia. Bilateral trade in goods between the two partners has risen steadily in recent years, reaching almost EUR48 billion in 2017, while bilateral trade in services added an additional EUR27 billion. The negotiations aim at removing trade barriers, streamlining standards and putting European companies exporting to or doing business in Australia on an equal footing with those from countries that have signed up to the Trans-Pacific Partnership or other trade agreements with Australia. The Council of the EU authorised opening negotiations for a trade agreement between the EU and Australia on May 22, 2018.

EU-US (Trans-Atlantic Trade and Investment Partnership): This agreement was expected to increase trade and services, but it is unlikely to pass under a Trump administration in the US.

Source: WTO Regional Trade Agreements database

7. Investment Policy

7.1 Foreign Direct Investment

Source: UNCTADDate last reviewed: September 13, 2018

7.2 Foreign Direct Investment Policy

The government is supportive of foreign investment and, as well as undertaking regulatory reform, it has established the Investment Promotion and Competition Directorate, based in the Ministry of Economy, which is tasked with providing advice and strategies for investment promotion and the removal of investment barriers. There are no performance requirements for foreign companies, and there are also very few restrictions on foreign exchange.

Substantial tax incentives are provided, including up to 100% reduction in corporate profit tax for foreign investors, with the government also having introduced real estate incentives to encourage investment in more rural areas of the country.

Foreign property ownership is restricted. Although EU member states can purchase property on the same basis as Croatian citizens, for those outside of the EU, property rights are based on reciprocity (dependent upon whether Croatian citizens can purchase property in the corresponding country). These restrictions do not apply for foreign investors incorporated as a Croatian legal entity.

The economy minister has presented a programme of regional support for capital investments aimed at maintaining or increasing employment figures, valued at HRK90 million. He also pointed to a further HRK250 million which has been earmarked for projects designed to increase value and export shares.

Croatia is keen to establish itself as a centre for automotive manufacturing, and, as such, has been developing the Croatian Automotive Cluster since 2007. This cluster has 50 members, and is active in research and development, as well as automotive parts production and assembly. Another four clusters have been established in shipbuilding, textile manufacturing, agricultural equipment and interiors, with around 140 member companies in total.

The Croatian Bank for Reconstruction and Development (HBOR), as of 2015, supports local manufacturers in the construction of ferries and tankers for the Turkmenistan and Norwegian governments. In 2014, the bank also signed a credit agreement worth USD84 million with Russian developers for the construction of a holiday resort in Russia, on the condition that construction materials and services are sourced from Croatia, which would benefit more than 50 Croatian companies. This demonstrates that local manufacturers will receive funding priority, which may make it more challenging for foreign companies to receive financial support in certain heavy manufacturing industries.

There are currently 831 companies in full state ownership, and legislation provides that private entities can compete with state-owned enterprises (SOEs) under the same conditions with regard to access to markets, credit and other business operations. In practice, though, there have been instances where political influence in the SOEs had a negative effect on competition, as the supervisory boards of SOEs include political figures that report directly to the government.

13 free trade zones (FTZs) are located at the sea ports of Pula, Rijeka, Split and Ploče, and other strategically located zones in Krapina-Zagorje, Kukuljanovo, Osijek, Ribnik, Slavonski Brod, Split-Dalmacija, Varaždin, Vukovar and Zagreb.

General Incentives:

- Exemption from custom duties and VAT

- Expedited customs procedures

- Local logistics hubs

- For investment in development and innovation activities, a non-refundable grant shall be approved for the purchase of plant/machinery amounting to 20% of the actual eligible costs for purchasing plant/machinery, in the maximum amount of EUR500,000, provided that the purchased plant/machinery represents high technology equipment.

- An incentive can be granted for the investment project if the minimum investment in fixed assets is EUR5 million and 50 new jobs are created within a three-year period from the start of the project. The percentage of non-refundable subsidies depend on the unemployment rate of the county where investment is located. Those projects can benefit from additional non-refundable subsidies between 10% and 20% of the eligible costs of investments for:

Construction of a new factory, production facility, or tourist facility

Buying of new machines (i.e., production equipment)

- The non-refundable subsidies could be up to EUR1 million, depending on the applied percentage of the eligible costs, with the condition that the part of investment in the machines/equipment equals at least 40% of the investment and that at least 50% of those machines/equipment are of high technology.

- Labour intensive investment projects in fixed assets are those with at least 100 new jobs created within a three- year period from the start of the project. Initial employment incentives can be increased by an additional 25% for up to 300 new jobs, 50% for a minimum of 300 new jobs, and up to 100% for minimum 500 new jobs.

Source: US Department of Commerce, Fitch Solutions

8. Taxation – 2018

Value Added Tax: 25%

Corporate Income Tax: 18%

Source: PwC Tax Summaries 2018

8.1 Important Updates to Taxation Information

The headline corporate tax rate in Croatia is 18%; however, Croatia has so many corporate tax exemption schemes that the majority of businesses do not need to pay any corporate profit tax. This is a strong competitive advantage for investors, since Croatia's tax levels are, therefore, lower than the average in the EU-27. The current corporate income tax system was introduced in Croatia in 2005 and entails several tax incentives and tax break schemes. For instance, the corporate income tax is reduced from 20% to 10% for the first 10 years, if a company invests EUR0-1.5 million in production facilities and equipment and employs at least 10 people (which is true for the majority of businesses). The corporate tax level is reduced to 7% for the first 10 years, if a company invests EUR1.5-4 million and employs at least 30 people. The corporate tax rate is reduced to only 3% if a business invests EUR4-8 million and the company employs at least 50 people. Full corporate tax exemption is granted, if the company invests more than EUR8 million and employs more than 75 people. Furthermore, companies gain tax holidays when they base themselves in certain areas, such as hill and mountain areas and free trade zones. This is a competitive advantage for investors and foreign businesses operating in the country, as they can save substantial amounts of money.

The general VAT rate is 25%. A reduced rate of 13% is applicable for activities, such as tourism, agriculture and energy production. Another reduced rate of 5% is applicable for items, such as bread, milk, educational material and newspapers.

Due to the high emigration levels of highly qualified individuals from Croatia, the country is flexible when it comes to importing labour to meet its market needs. Although the country is a part of the EU and is open to international migrants, the majority of migrants are unskilled workers from neighbouring countries. This is a cause of domestic tension, considering Croatia's already very high unemployment rates.

9.2 Foreign Worker Permits

In recent years, due to EU membership, the Croatian government has been under pressure to increase annual work permit quotas by 40% for foreign workers. As an EU member, Croatia can easily recruit for its skills shortages from within the Union, as citizens have freedom of mobility. Work permits for non-EU nationals are issued for a period of up to two years (EU Blue Card) and require the applicant to go through a higher number of bureaucratic procedures than citizens of the EU.

9.3 Visa/Travel Restrictions

African and some Asian, Middle Eastern and Latin American countries require a visa. As a member of the EU, Croatia does not impose any travel restrictions upon any other European state. Countries such as the US, Canada, Australia, Japan and South Korea, along with a number of Latin American states, likewise, do not face any travel restrictions. However, African citizens, along with most Asian and Middle Eastern citizens, may not travel to Croatia without obtaining a visa in advance.

Source: Government websites, Fitch Solutions

10. Risks

10.1 Sovereign Credit Ratings

Rating (Outlook)

Rating Date

Moody's

Ba2 (Stable)

10/03/2017

Standard & Poor's

BB+ (Positive)

23/03/2018

Fitch Ratings

BB+ (Positive)

06/07/2018

Source: Moody's, Standard & Poor's, Fitch Ratings

10.2 Competitiveness and Efficiency Indicators

World Ranking

2016

2017

2018

Ease of Doing Business Index

39/189

43/190

51/190

Ease of Paying Taxes Index

38/189

49/189

95/190

Logistics Performance Index

51/160

N/A

49/160

Corruption Perception Index

55/176

57/180

N/A

IMD World Competitiveness

58/61

59/63

61/63

Source: World Bank, Transparency International

10.3 Fitch Solutions Risk Indices

World Ranking

2016

2017

2018

Economic Risk Index Rank

65/202

Short-Term Economic Risk Score

61.5

64.4

63.3

Long-Term Economic Risk Score

58.9

57.8

59.2

Political Risk Index Rank

60/202

Short-Term Political Risk Score

60.4

65.0

66.3

Long-Term Political Risk Score

70.5

71.4

71.4

Operational Risk Index Rank

45/201

Operational Risk Score

62

63.8

63.1

Source: Fitch SolutionsDate last reviewed: September 13, 2018

10.4 Fitch Solutions Risk Summary

ECONOMIC RISKCroatia's short-term economic outlook has improved as domestic demand recovers and record tourism continues to drive solid export growth. Most significantly, a reduced budget deficit will ease the immediate risks to stability and set public debt on a downward trajectory.

OPERATIONAL RISKCroatia offers a relatively safe operating environment and is one of the most appealing destinations for investment in the South East Europe region. Foreign and local businesses, alike, face limited crime and security risks, and the country benefits from having a strong police force and membership of various regional security initiatives.

A Schengen Visa is needed for travel to Croatia (as well as the other EU states) and is valid for up to 90 days. Application must be completed prior to travel.

Holders of Hong Kong SAR, BNO and Macao SAR passports are entitled to a visa-free entry to Schengen countries lasting no more than 90 days in any six-month period from the date of first entry in the territory of the Member States.

Both the Hong Kong Document of Identity (HKDI) and the Macao Travel Document are recognised by all Schengen countries. The holders of such documents, however, need to apply for a Schengen visa.

The Consulate General of Croatia accepts visa applications only if Croatia is the country of your main destination (if you are going for tourism, the main country of your destination is the one where you spend the longest time, not necessarily the country of your first entry).

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